Many Indian nationals spend time working abroad. Whilst working in the United Kingdom Pension benefits may accrue via employers’ occupational or personal pension schemes.
Depending on the length of time and contributions, pension funds of significant value can accrue. If the individual returns to India or becomes resident outside of the United Kingdom a QROPS should be considered. The QROPS should be in a jurisdiction with a double taxation agreement with India.
Under section 9(1)(iii), pension accruing is taxable in India only if it is earned in India. Pensions received in India from abroad by pensioners residing in this country, for past services rendered in the foreign countries, will be income accruing to the pensioners abroad, and will not, therefore, be liable to tax in India on the basis of accrual. These pensions will also not be liable to tax in India on receipt basis, if they are drawn and received abroad in the first instance, and thereafter remitted or brought to India.
While the pension earned and received abroad will not be chargeable to tax in India if the residential status of the pensioner is either 'non-resident' or 'resident but not ordinarily resident', it will be so chargeable if the residential status is 'resident and ordinarily resident'. The aforesaid status of 'ordinarily resident' cannot, however, be acquired by a person unless he has been resident in India in at least nine out of the preceding ten years.
A QROPS will allow the release of UK Pension funds facilitating gross cash and/or income payments to be made to an Indian resident.
Country Profile
Despite numerous pension reforms ushered in during the last two decades, India still faces many social, financial and investment challenges. The country has a growing elderly population with no formal access to retirement benefits. Its workforce consists of two groups: organized and unorganized. About 10 percent of India’s workforce are organized workers, and as such, are covered under state provident funds or private pension funds. The remaining 90 percent of workers fall into the unorganized sector, with only minimal benefits.
Like many developing countries, India has no universal social security system, and the current system provides benefits mainly for the poor. However, because the benefits are meager, the majority of India’s elderly still depend on their children for financial support.
The existing pension schemes in India are varied and complex.
This article provides an overview of retirement benefits in India and examines relevant issues that are important from an employer’s point of view. It covers income replacement ratio, the fringe benefit tax (FBT), and the challenges that employers are facing.
India’s social security system falls into four categories:
- Civil service and military pensions
- Statutory pension scheme and provident fund scheme for private sector workers
- Voluntary savings schemes for self-employed and unorganized sector workers
- Targeted social assistance schemes and welfare funds for the economically poor
The following mandatory retirement benefits are provided:
- The Employees’ Provident Fund (EPF) Scheme
- Gratuity Benefit Scheme
| | Mandatory | Plan type | Employer contribution | Employee contribution
|
Employees’ Provident Fund | Yes | Defined contribution (if managed by government) | 12% of basic salary | 12% |
Gratuity | Yes | Defined benefit of 15 days per year of service (INR 350,000 lump sum max) | Large companies typically fully fund the liability | 0 |
Supplementary Superannuation | No | Defined benefit or defined contribution - no fixed formula | Up to 15% of basic salary | 0 |
The Employees’ Provident Fund and Miscellaneous Provisions (EPF & MP) Act of 1952 was passed to provide social security benefits to workers and, in the case of their death, to their dependents. Benefits under the Act are arranged under three schemes:
A) Employees’ Provident Fund (EPF) Scheme, 1952
B) Employees’ Pension Scheme (EPS), 1995
C) Employees’ Deposit Linked Insurance (EDLI) Scheme, 1976
Membership in the EPF fund is mandatory for entities employing 20 or more people and is compulsory for all employees with earnings of INR 6,500 (USD 163) or less per month. Participation is optional for employees earning above this amount, but most multinational corporations provide the provident fund benefit to all employees. Employee membership continues irrespective of the level of earnings, and the fund is portable. If an employee decides to switch jobs, his or her account can be transferred to the new employer.
Employees’ Provident Fund Scheme, 1952
The EPF is a defined contribution (DC) scheme. Employers contribute 12 percent of eligible earnings, 8.33 percent of which is diverted to the EPS - up to INR 6,500 (USD 163) a month. Employees must make a matching contribution of 12 percent of eligible salary.
Contributions (except the portion diverted to EPS as explained below) are credited to individual employee accounts. Interest is credited to member accounts at the rate declared by the government of India. Partial withdrawals by way of advances are allowed to members for specified purposes, including housing, marriages, etc. A member’s full account balance is paid out in the case of normal retirement, total and permanent disablement, death in service, and early retirement. The benefit is paid in lump-sum form only.
EPFs can be administered by the government agency or by employers through private trusts. Due to high service costs and poor past investment performance, companies are looking at moving their EPFs to the private sector, where greater efficiency, investment flexibility and work transparency can be had.
Employees’ Pension Scheme, 1995
EPS is a defined benefit (DB) scheme run by the Employees Provident Fund Organisation (EPFO), the largest social security provider in India, and is guaranteed by the government. The EPS applies to all workers covered under the EPF & MP Act of 1952. As mentioned above, 8.33 percent of covered earnings, up to INR 6,500 (USD 163) per month, is diverted to the EPS from the employer’s contribution of 12 percent to the EPF. The scheme provides pensions for life to members upon retirement, broadly based on the following formula:
(Pensionable Salary* x Pensionable Service) / 70
*The maximum pensionable salary is limited to INR 6,500 (USD 163) per month.
In the event of death or disability, a lifetime income may also be paid.
Employees’ Deposit Linked Insurance Scheme, 1976
EDLI was established to provide insurance coverage to surviving relatives after the early death of an employee. The employer contributes at the rate of 0.50 percent of monthly eligible earnings up to INR 6,500 (USD 163) to fund an additional amount paid on death subject to a ceiling of INR 60,000 (USD 1500). As the name suggests, the coverage paid to an employee's survivors is linked to the balance in the employee's EPF account.
Gratuity Benefit Scheme
Under the Payment of Gratuity Act, 1972, a gratuity is payable to an employee or beneficiary upon termination of employment after such employee has rendered continuous service for not less than five years. The condition of completion of five years’ continuous service is not applicable where termination of the employment of an employee is due to death or disablement.
The payment of the gratuity benefit is a statutory requirement for employers with a workforce of 10 or more employees, and it is applicable to all permanent employees, regardless of category or salary. The benefit is paid in lump-sum form. The minimum benefit is approximately two weeks’ salary for each year of service, with an upper limit on the statutory benefit amount (currently) INR 350,000 (USD 8,750). Gratuity benefits higher than those under the statutory scale can be provided by employers.
Income Replacement Ratios
A typical employee earning a basic monthly salary of INR 40,000 can expect at retirement a benefit from the EPF and the Gratuity Benefit Scheme that provides an annuity equal to approximately 34 percent of total earnings. The low level of income replacement is due both to the relatively early age of normal retirement (58) and to the fact that total earnings usually include several allowances, which are not subject to EPF contributions.
Assumptions
Entry age: 30,- Monthly basic salary at entry: INR 40,000 (USD 1,000). Salary escalation rate: 7.00 percent per annum. Ratio of basic salary to total remuneration is 50 percent. Return on provident fund: 8.50 percent per annum. Return on superannuation fund: 10.00 percent per annum. Normal retirement age: 58 years (chosen to represent an average expectation of retirement).
It should be noted, however, that the moneys available under the EPF at retirement will be less than the projected amounts because the EPF permits early withdrawals while in service.
Superannuation
As a result of the low level of income replacement at retirement from the EPF and the gratuity benefit, many employers have set up superannuation plans, either on a DB basis or, more typically, as a DC plan.
Under the existing Income Tax Act, the employer can contribute to a superannuation scheme a percentage of earnings that, together with the employer’s contribution to the provident fund, does not exceed 27 percent of eligible earnings (basic salary and dearness allowance, if any). For employees where there is a contribution to the EPF, the maximum tax-effective contribution to the superannuation plan is therefore 15 percent - and this tends to be the typical level of employer contribution.
The trustees of superannuation schemes can either manage the investments in the accumulation stage themselves or hand over the investment management to a life insurance company. Regardless of where the funds are managed, the income tax rules require that benefits be paid out as life annuities from insurance companies.
Some companies are designing vesting scales that help with employee retention, in which employees will get a higher vested portion of benefits if they remain in service for a longer period.
Impact of the Fringe Benefits Tax
The FBT was first introduced in 2005 and requires the employer to pay a tax of 33.99 percent on any employer contributions to a superannuation scheme that exceed INR 100,000 (USD 2,500) per annum per employee. For comparison, an individual in the uppermost tier of income has to pay income tax at the rate of around 30 percent.
Some companies have adopted an approach of putting an upper limit of INR 100,000 (USD 2,500) per annum on the contribution amount. A few companies have contemplated discontinuing contributions to superannuation schemes-, and are instead passing the equivalent value of these contributions directly to employees as extra salary. For a DC plan with a 15 percent contribution, a basic salary of up to INR 666,667 (USD 16,667) per annum will not attract the FBT.
Annual base salary | Annual total salary (cost to company) | Contribution to superannuation @ 15% | FBT amount | FBT as proportion of annual total salary |
6,250 | 12,500 | 938 | 0 | 0 |
12,500 | 25,000 | 1,875 | 0 | 0 |
25,000 | 50,000 | 3,750 | 425 | 0.85% |
50,000 | 100,000 | 7,500 | 1,700 | 1.70% |
100,000 | 200,000 | 15,000 | 4,249 | 2.12% |
200,000 | 400,000 | 30,000 | 9,347 | 2.34% |
Amounts are in USD
Current developments
The Institute of Chartered Accountants of India (ICAI) has introduced Accounting Standard 15 (Revised 2005), hereinafter called AS 15 (R). This standard is mandatory for accounting years commencing on or after December 7, 2006, and is modeled on IAS 19, although there are a few variations. The revised standard comments on actuarial assumptions:
§ Assumptions should be the company’s best estimates.
§ Assumptions are to be unbiased.
§ Assumptions are to be mutually compatible.
The standard is also prescriptive about the assumption for the discount rate, which has to be determined by reference to government securities for a duration matching that of liabilities.
Does an EPF count as a DB or a DC scheme?
As mentioned above, it is possible for employers to opt out of the government EPF and set up their own schemes. (The deadline for applying for exemptions from the EPFO has been extended by one year to March 31, 2009,) The employer must provide for the fund return as declared by the government. Accordingly, these count as DB schemes for the purposes of Accounting Standard 15 (Revised), and the position under US GAAP would also need to be examined.
Pension reforms in India
The government has now set up a Pension Fund Regulatory Development Authority (PFRDA). The PFRDA is “an authority to promote old-age income security by establishing, developing and regulating pension funds, to protect the interests of subscribers to schemes of pension funds and for matters connected therewith or incidental thereto.” One key impact of the government’s initiative was the introduction of a DC-type of plan, the New Pensions System (NPS), for new central government employees.
It is expected that when the current Pensions Bill gets approved by the Parliament, it will also give legal authority to the PFRDA to further open doors for creation of a structure for private plans. NPS is intended to be eventually available for the entire population as a voluntary medium for old- age provision. We believe these pension reforms will then percolate into the private sector, and perhaps the PFRDA will act as a regulator for the gratuity and supplementary pension schemes as well.
What’s on the horizon?
Retirement benefits, suitably designed, are likely to play a major role in the attraction and retention strategies of companies in India. The onus is on employers to educate employees about the need for reasonable retirement provisions - that is, income replacement ratio of 60 percent or higher. Companies providing attractive retirement benefits will be able to differentiate themselves from competitors.
In a country such as India, where social security measures are insignificant and individuals are often either ill-organized or inattentive to planning and providing for their old age, the employer has a significant financial and social role to play. This may have long-term consequences for employers in terms of workforce management, and some employers might want to look more sympathetically toward pension schemes despite the current FBT. Employers should also begin to educate employees about the need for self-provision for old age.
